[[Actuarial Notes Wiki|Wiki]] / [[Exam 5 (CAS)]] / **Profit and Contingency Provision**
## Definition
==Profit and Contingency Provision== is the portion of the insurance rate intended to provide a return to capital providers and a margin for unforeseen contingencies and parameter uncertainty.
## Components
### Underwriting Profit
- Return on equity
- Compensation for risk bearing
- Competitive considerations
### Contingency Margin
- Parameter uncertainty
- Catastrophe potential
- Estimation error
- Unforeseen events
## Target Levels
```
Typical profit provisions:
Personal lines: 3-5%
Commercial lines: 5-7%
Specialty lines: 7-10%
Varies by:
- Line volatility
- Capital requirements
- Market conditions
- Regulatory environment
```
## In Rate Formula
```
Rate = (Losses + LAE) / (1 - Expenses - Profit%)
Example:
Pure premium: $250
Variable expenses: 20%
Fixed expenses: 10%
Profit & contingency: 5%
Rate = $250 / (1 - 0.20 - 0.10 - 0.05)
= $250 / 0.65
= $385
```
## Considerations
### Setting Profit Provision
- Cost of capital
- Risk-adjusted return requirements
- Competitive marketplace
- Regulatory constraints
- Return on equity targets
### Trade-offs
```
Higher profit provision:
+ Better returns
+ More cushion for adverse development
- Less competitive
- May lose market share
Lower profit provision:
+ More competitive pricing
+ Higher market share
- Lower returns
- Less margin for error
```
## Related Concepts
- [[Pure Premium Method#Definition]]
- [[Loss Ratio Method#Definition]]
- [[Underwriting Profit#Definition]]
## References
- Werner & Modlin, Chapter 5
- CAS Ratemaking Principles